By Laila Kearney
NEW YORK (Reuters) - Slow revenue growth and challenges from the recent U.S. tax reform are hurting many U.S. states' credit quality, said global investment management firm Conning on Tuesday as it issued a negative outlook for the sector for the rest of 2018.
Revenues are largely trending below expenditures and U.S. gross domestic product, leading to shrinking reserves for many governments, Conning said in its "State of the States" report.
Based on several economic indicators, general fund operations and business activity, the highest-rated states are Utah, Colorado, Idaho, Texas and Washington. The lowest-ranked are Connecticut, New Mexico, Illinois, Mississippi and Kentucky.
Northeastern states were the least creditworthy while Southeastern and Western states have strong economic growth.
"We believe that above-average economic activity foreshadows
credit upgrades and better relative bond performance," the report said.
California, the largest debt issuer of any state, showed the most improvement, thanks to a 7 percent revenue increase in 2017 and healthy reserves, Conning said.
Conning's last report in October also showed an overall lag in revenues, but U.S. tax reform passed in December poses new problems to state credit quality, he said.
New federal tax rules cap state and local tax deductions at $10,000 for individuals, disproportionately hitting residents of high-tax states, the report said.
"States with high income and property taxes risk losing even more higher-income residents to lower-taxed states," said Paul Mansour, head of municipal credit research at Conning.
Tax law changes could force high-tax states, including New York and New Jersey, to lower taxes to keep residents, but states with lower taxes could get additional income tax revenue, the report said.
Other fiscal challenges include the rising cost of pensions, Medicaid and other fixed costs, which have led to cutbacks in new project spending and debt offerings. This would boost states' creditworthiness, Conning said.
"States have done a good job at holding off from issuing debt unless there is a revenue source behind it, displaying good governance and fiscal discipline," Conning said.